Despite many months of build-up and anticipation in the run-up to one of the most celebrated IPOs ever, Alibaba captured the imagination of millions of investors and of capitalists everywhere when, a week ago, in listing its shares publicly for the first time ever, it automatically became one of the 25 most valuable public companies in the world. And however prodigious the company may be in developing the largest e-commerce platform in the most populous country in the world (it is very prodigious indeed) what’s perhaps most admirable today is the impeccable timing of its founder and chairman in taking it public. A better rags-to-unimaginable riches story has seldom been told anywhere at anytime. How so? Well, we cannot recall a time in the last decade and a half in which investors had a greater appetite for anything mega-cap, with the S&P 500 having achieved a 3-year annualized return, through Wednesday’s close, of 20.7% and a cumulative, price return of 71.8%, which does not include dividends. A heck of a run if there’s ever been one.
It is with this backdrop that the Barron’s 400 Index once again went through its habitual semi-annual rebalance, coincidentally on the same day the world welcomed BABA to the public markets stage. And in true fashion, B400’s knack for zigging while others zag did not disappoint when, in one of the index’s most noticeable bets on a segment of the market in recent years, it trimmed its exposure to large caps by 14% and to mid caps by almost 8% and increased its exposure to small caps by 69%. Wow! Now, before running for the exits with the rest of the market herd, do keep in mind that the index is still very well balanced with 28% of its constituents having a market cap above $10 billion and only 22% of them below $1 billion. To round things up rather nicely, companies with between $1 billion and $10 billion in market cap, otherwise know as mid caps, make up exactly 50% of the index components. No, this was not by design. This was simply how the bottoms-up selection of B400 played out when all other factors such as sector caps and liquidity filters were applied. Nicely done indeed. So, why the shift away from larger companies in favor of smaller ones? Regular readers of this column may guess the answer: GARP. In replacing 39.75% of its constituents, B400 substituted a group of companies that was trading at 19.5 times next year’s earnings for one that now trades, on average, at 17.4 times that same metric. And, on average, the new group has grown earnings per share by 34% in the last three years compared to 28% for the March selections. In other words, B400 once again went shopping for growth-at-a-reasonable price.
Before we continue breaking down the latest rebalance, though, let’s briefly discuss the elephant in the room lest we be labeled as disingenuous in our writing about our index: small caps are unquestionably in the midst of a correction, which has made life for B400 a bit rough of late. The Russell 2000, a widely followed proxy for the market’s smallest segment, is down 6.6% from its peak on March 4. Over the same time period, the Dow Jones U.S. Total Stock Market Index, B400’s benchmark, is up 4.7%, the S&P 500 is up 6.6% and B400 is up only 0.5%. A comparable mid cap index, the S&P 400, is up 0.4%. More ominous perhaps for chartists and market technicians, the Russell 2000’s 50-day moving average is now trading below its 200-day moving average, while large swaths of companies in the small cap benchmark are well into correction territory with 10%+ losses. In our view, as the Federal Reserve readies the end of its third round of quantitative easing next month, volatility will continue to rise, shaking smaller companies with greater impetus than their larger brethren. That is, until fundamentals return to the fore like they always do. So, rather than compare the new crop of B400 selections to the March constituents, we thought it might be more interesting at this time to compare them against the S&P 500 as a good proxy for U.S. large caps, which, until recently, could do no wrong.
Aggregate revenue for all companies in the S&P 500 grew, on a 12-month trailing basis, by 3.2% in the last year. By comparison, B400 companies grew their top line, based on the same metrics, by 7.0%. Operating income for the S&P, again in the aggregate, grew 9.7% in the last year while, net income actually outpaced growth in operating earnings by four points, growing 13.8% in the last 12 months. This, no doubt, a testament to the remarkable ability of large U.S. companies to do more with less by increasing productivity, and not without a hearty dose of share buy-back, when measuring profits on a per share basis. B400, however, is a more prodigious grower of earnings, with aggregate operating income and net income up by 18.2% and 25.3% respectively, also in the last 12 months. And perhaps most important to shareholders, though seldom measured, B400 companies, in the aggregate, grew shareholders’ equity last year by 11.3% while for the S&P 500 it was a 7.8% increase. The table below illustrates some of the aggregate growth rates and valuation multiples for both indexes, on an equally weighted basis.
|Barron’s 400 Index||S&P 500 Index|
|Aggregate Market Cap||$8.6 trillion||$19.2 trillion|
|Agg. Market Cap 1Y Growth||38.1%||25.4%|
|Agg. Market Cap 3Y Growth||85.6%||51.6%|
|LTM Revenue 1Y Growth||7.0%||3.2%|
|LTM Revenue 3Y Growth||26.0%||14.4%|
|LTM Op. Income 1Y Growth||18.2%||9.7%|
|LTM Op. Income 3Y Growth||41.2%||17.7%|
|LTM Net Income 1Y Growth||25.4%||13.8%|
|LTM Net Income 3Y Growth||53.2%||21.0%|
|Agg. Shareholders’ Equity||$2.3 trillion||$7.1 trillion|
|Shareholders’ Equity 1Y Growth||11.3%||7.8%|
|Shareholders’ Equity 3Y Growth||32.2%||17.6%|
|Market Cap to LTM Revenue||2.1||1.8|
|Market Cap to LTM Op. Income||12.2||12.0|
|Market Cap to LTM Net Income||18.1||18.9|
|Market Cap to LTM Sh. Equity||3.8||2.7|
B400 Favors Financials, Shuns Materials
The latest rebalance was equally interesting from a sector rotation perspective considering that, for the first time in the last couple of years, Consumer Discretionary has been displaced as the biggest sector in the index, based on number of components, in this case by none other than Financials. That sector gained 23 components at the rebalance, largely at the expense of Materials, which lost 11 companies and now represents a mere 4.0% of the index. Consumer Discretionary, at 73 components (18.3%) and Industrials at 72 (18.0%) round out the top three sectors, with a combined 56.3% weight. This should bode well for B400 if GDP growth continues to accelerate in the U.S., which would favor cyclical industries and, ironically, if the much-anticipated upcoming rise in interest rates is limited to the short end of the curve, which would be conducive to better bank profits and an overall better allocation of capital in the private economy. And once skittish investors that may have moved to the sidelines recently feel comfortable enough to jump back in, which may take a few months, they could do worse than owning a group of companies geared toward healthier U.S. economic growth.
In closing, a few words about some of the companies that were not replaced during the latest rebalance; in fact, that haven’t been replaced in a while. A little over one fifth of the Barron’s 400 components have been part of the index for at least two consecutive years (87 companies in total), which goes to show how adept B400 is at straddling not only growth and value but also passive and active investing characteristics, which we wrote about in an earlier post. 52 companies, or 13% of the index, have been selected for at least three years running. And 20 companies, all of which appear below, have been selected to the Barron’s 400 Index for at least five consecutive years. Considering that on any given selection period only about 8% of all companies listed on major U.S. exchanges, which are covered by MarketGrader, are selected to the index, this is a feat worth commending. Those responsible for the management of those companies should feel proud of their sounds stewardship on behalf of their shareholders, which is what ultimately B400 seeks to recognize. Congratulations to them and to all current Barron’s 400 companies.
|Ticker||Company Name||Consecutive Years|
|APEI||AMERICAN PUBLIC EDUCATION INC||5|
|BBBY||BED BATH & BEYOND INC||5|
|CMG||CHIPOTLE MEXICAN GRILL INC||5|
|CTSH||COGNIZANT TECHNOLOGY SOLUTIONS CORP||5|
|DLTR||DOLLAR TREE INC||5|
|IBM||INTERNATIONAL BUSINESS MACHINES CORP||5|
|NUS||NU SKIN ENTERPRISES INC||5|
|PCLN||PRICELINE GROUP INC||5|
|PII||POLARIS INDUSTRIES INC||5|
|SHOO||MADDEN STEVEN LTD||5|
|UNH||UNITEDHEALTH GROUP INC||5|
|WMT||WALMART STORES INC||5|
|WRLD||WORLD ACCEPTANCE CORP||5|